NEW DELHI: The latest point of friction between the RBI and the government is an attempt by the government to help shore up its balance sheet through a transfer of reserves.
The Ministry of Finance is seeking a transfer of more than Rs. 3 lakh crore, which is a third of the central bank’s reserves, to be transferred to the government. The RBI hasn’t budged so far. The main reason the government wants this money transferred is to fund the fiscal deficit. The government deems the RBI to be conservative in assessing risks and doesn’t think it needs a very high amount of reserves; which is used in times of financial instability and other contingencies.
One of those financial emergencies is the making sure the banking sector doesn’t go dry. In a sector that is already relatively unstable, the RBI introduced the Prompt Corrective Action (PCA) framework which limits lending, branch network expansion and distribution of dividend on weak banks. The RBI’s income usually comes from the returns it earns on its foreign currency assets such as bonds, treasury bills and deposits with other central banks.
In light of the rift between the RBI and the government going public, former RBI Governor Raghuram Rajan offered advice saying in part, “The RBI is something like a seat belt. As a driver, the driver being the government, it has the possibility of not putting on a seat belt but of course if you do not put on your seat belt you get into an accident and the accident can be quite severe”.
While there isn’t total independence when it comes to the RBI; the government can request for funds if need be; provided the reasoning is based on merit and principle and facts. It’s imperative that both the RBI and the government think about fiscal prudence in this situation. The optics of the government ordering the central bank to hand over a third of its reserves at this particular point in time aren’t great. The government has to lower trust deficit that exists.
On the issue itself, of the government wanting reserves to be transferred, it has the right to do so on principle. The government would do well to use the money to recapitalize public sector banks. Niranjan Rajadhyaksha, Senior Fellow at IDFC, in a column for Livemint writes on the statutory reserves – “The adequacy of statutory reserves should be examined given the fact that the RBI is a full service central bank, most of its assets are foreign securities, the exchange rate is a managed float rather than completely flexible”.
What Niranjan offers is pragmatic, suggesting that the RBI set an expert committee to assess how the balance sheet of the RBI can and should be capitalised. It can even look into whether this is even a viable option. In South Korea, its central bank has the legal right to request extra capital from the government. He continues in his column – “Economist Alex Cukierman showed in a 2011 article that the specific conditions of individual countries matter when it comes to determining whether central bank capital is adequate”.
Alex Cukierman’s point somewhat goes against what the government is arguing which is backed up by the 2016 Economic Survey through comparison of other central bank balance sheets, that the RBI holds more statutory reserves than needed. Cukierman’s point is that a generalization by just comparing other countries central banks isn’t adequate. The factors that need to be taken into consideration are nature of the exchange rate, extent of fiscal policy dominance over monetary policy etc.
Former RBI Deputy Governor Shyamala Gopinath said in part, “It (reserves) cannot, therefore, be treated as free reserves eligible for distribution. Any utilisation of these funds also has consequences for inflation and money supply”. The RBI is required to maintain a strong balance sheet. The excess that the RBI holds as compared to other central banks is due to the amounts held in currency and gold revaluation. The gains arising out of this cannot be necessarily treated as free reserves to be transferred to the government. For that to happen, the government and the RBI need to form clear guidelines on the terms and conditions of the transfer if it is to take place.